Buffett: Why Smart People Do Dumb Things

April 29, 2020 by Jon

Warren Buffett appeared on Adam Smith’s Money Game in 1998. It was the follow-up show to Adam Smith’s Money World that ended a year or two earlier. Smith (aka George Goodman) interviewed Buffett around the time of the 1998 annual meeting.

One of the questions Smith asked was related to I.Q. – combining brilliance and investing won’t guarantee success. Smith wanted to know why. Buffett felt an important third ingredient was needed. Here’s what he had to say:

Adam Smith: Why do smart people do dumb things?

Warren Buffett: That’s the big question. Why do they do it in investing? Why do they do it in managing businesses? Because you have all these smart people out there. The money doesn’t go to the people with the highest I.Q. There would be a very poor correlation between I.Q. and investing and results. And you say to yourself why does somebody with a 500-horsepower motor only get 100-horsepower out of it? And I would say that if you look at the intellect as being the horsepower that’s available, but you look at the output as reflecting the efficiency of that motor, it is rationality that causes the capacity to be translated in output.

Now, what interferes with rationality? It’s ego. It’s greed. It’s envy. It’s fear. It’s mindless imitation of other people. I mean, there are a variety of factors that cause that horsepower of the mind to get diminished dramatically before the output turns out. And I would say if Charlie and I have any advantage it’s not because we’re so smart, it is because we’re rational and we very seldom let extraneous factors interfere with our thoughts. We don’t let other people’s opinion interfere with it. We don’t get– we try to get fearful when others are greedy. We try to get greedy when others are fearful. We try to avoid any kind of imitation of other people’s behavior. And those are the factors that cause smart people to get bad results.

Adam Smith: But can you define them as smart people if they do all the things that you said? If they imitate other people. If they’re moved by greed, fear, and so on?

Warren Buffett: Well, they are people that would do very well on an I.Q. test. And they can play a great game of chess or whatever it may be. I mean, they have the intellectual capacity to do it. The wires are hooked up but something causes them to get off on different tracks and the wires just start flickering. And usually, it’s those emotional factors that– You know, I’ve seen an awful lot of people on Wall Street that bring 150 I.Q. to the party and, you know, you have a chapter in your first book that said anything times zero is zero. So you have to make sure you don’t have one of those decisions in there that has a big zero in it.

Adam Smith: Can you think of an example of somebody really smart doing something really dumb?

Warren Buffett: Oh, I can think of lots of examples, both in business and investing. I’m not going to name names, but I–

Adam Smith: Don’t name names, just tell me a story in investing.

Warren Buffett: Well, you know, you saw it in the late ’60s and chronicled it in terms of smart people. And it’s because they can’t stand inaction sometimes. You see it in the corporate arena where people make very dumb acquisitions. I mean, you saw the oil companies in the ’70s all rushing after each other into various things. And, actually, in the past, great companies like Coke and Gillette have gone into all kinds of different areas before they figured they had a pretty good business in razor blades or soft drinks.

Adam Smith: There is a huge wave of mergers going on right now. Do you think some of that is the ego of the CEO?

Warren Buffett: You don’t get to be a CEO by being a milquetoast. I mean, you have a certain amount of zest for action. In most cases that’s how people get to the top. And it is no fun if you’re CEO to look around and see your competitors and colleagues making deal after deal and being plastered all over the press and to sit there and say, you know, I don’t think these deals make much sense. That’s very difficult to do. And you’ve got other constituencies urging you on — your own people.

In an organization where other people are expanding enormously by acquisition, you will find it very difficult to resist the entreaties of the people below you who say why aren’t we doing something? I mean, I’ve heard that a lot of times in various businesses.

Adam Smith: So not being a lemming when all the other lemmings are running in a certain direction is a great advantage.

Warren Buffett: That’s true. You want to do your own running off cliffs in the right place. And that can work in reverse. When people are depressed, that’s the time often to be very aggressive. And you simply have to insulate yourself in some way from the emotions that are running around you. And that’s easy to say but it’s hard for people to do.